What Are Illicit Financial Flows? What Does This Report Measure?

Illicit financial flows are cross-border transfers of funds that are illegally earned, transferred, or utilized. These kinds of illegal transactions range from corrupt public officials transferring kickbacks offshore, to tax evasion by commercial entities, to the laundered proceeds of transnational crime.

The first, Hot Money Narrow (HMN), looks at money that has disappeared from the balance of payments. GFI infers that is likely to represent kickbacks, bribery, and other forms of unrecorded wire transactions. Countries that are rich in natural resources, like oil, tend to have higher HMN numbers relative to others. HMN accounts for about 20.3% of illicit financial flows estimated in this report.

The second, Gross Excluding Reversals (GER), looks at trade misinvoicing, a common method used by commercial entities for the cross-border movement of illegal money. Exporters and importers manipulate trade invoices to over-represent or under-represent the value of the goods they are shipping. Often, this will involve re-invoicing the goods through a secrecy jurisdiction. The result is that a certain sum of money disappears on one side of the border—either from the importer or exporter. We detect this by comparing what a country says it is exporting, and what the rest of the world says it imports from that country, and vice versa.

Certain types of trade misinvoicing are used for different purposes. Drug cartels and terrorist networks have been known to use it to launder money. Importers and exporters use it to evade customs duties. Other tax evaders, criminals and corrupt public officials in developing countries use it to hide wealth or ill-gotten gains. GFI’s methodology is unable to distinguish between the different sources of trade mispricing.

Further, illicit financial flows have a subversive effect on government in a few ways. First, they encourage corruption, by allowing corrupt public officials to siphon money away from public coffers and into secret offshore bank accounts. Second, every country case study that GFI has performed has shown that increased illicit financial flows grow a country's underground economy. As the underground economy expands, criminal elements become more powerful and more difficult for law enforcement to fight. To make matters worse, the research also shows that as a country's underground economy grows, criminals respond by moving more money out of the country, and so on. This vicious cycle helps to explain why illicit flows grew at 10% per year from 2002-2011.

Finally, illicit financial flows are one of the world's biggest, and least talked about, drivers of inequality. Those with the wealth and resources to use highly sophisticated money laundering techniques to smuggle money out of the country are almost exclusively powerful and affluent, and their victims are ordinary citizens.